High Frequency Traders Accused of Disconnecting Prices from Fundamentals

High-frequency traders have caused U.S. commodity futures prices to disconnect from market fundamentals of supply and demand since the 2008 financial crisis. An extensive and detailed analysis by the United Nations Conference on Trade and Development just confirms what we have shown again and again (most recently here in Silver) that HFT’s impact on the world is not all unicorn-tears and liquidity-providing. Markets are more exposed to ‘sudden and sharp’ corrections, and as Reuters notes “The strategy of those involved in high-frequency trading tends to reinforce the correlation between equities and commodities“. In a somewhat stunning conclusion from an academic treatise, the authors find “We are not saying that it’s all about speculators and (that) fundamentals don’t matter. But we are saying that they tend to matter less, except in extreme cases,”. Unlike other studies on the linkages, the UNCTAD study uses tick-data and finds correlations rising and trade size dropping as frequency increased dramatically since the crisis in 2008. Critically, one final consequence is that investors seeking to diversify or hedge against other investments in their portfolio are often disappointed as the increased HFT creates a destabilizing effect on commodities (increasing volatility) and can often create bubbles.

The number of Ticks (trades) has risen exponentially faster than the volume – as the black (ratio) line indicates – for WTI in this case.

And on a rolling 5-minute correlation basis – it is abundantly clear that there has been a regime shift in the relationship between US equities and WTI (in this example)…

Meta

Founded in 2007, iBankCoin is a provider of financial content with a distinctive voice. Through the unique personalities of its writers, the site offers a fresh perspective on financial news, and bold opinions on investment opportunities.